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Department of Economics
ECON 203 INTRODUCTION TO MACROECONOMICS
Fall 2009
COMMON FINAL EXAMINATION VERSION 1 AND ANSWERS
FIRST NAME:_______________________________
This is a three-hour exam (180 minutes). The questions are worth 150 marks altogether. It is a good
strategy to spend one minute per mark for your answers (150 minutes) and spend the remaining time
(30 minutes) to review your answers.
2.
3.
Write your answers for the multiple-choice questions on the computer scan-sheet with a pencil. For Parts
II to IV, write all your answers on this exam. Do not use additional booklets.
4.
You are allowed to use a non-programmable calculator and a dictionary. You may use either pen or pencil
to provide your answers for Parts II to IV.
Grades:
Part I:
__________
Part II:
__________
Part III:
__________
Part IV:
__________
Total:
Part I: Multiple Choice Questions. Write all answers on the computer sheet with a PENCIL (Total=25 marks).
1.
2.
3.
Monetary policy is expected to influence aggregate demand, output and employment through its effect on:
A) consumption expenditure.
B) investment expenditure.
C) government expenditure
D) Both A and B.
E) Both A and C.
4.
5.
.
6.
A good produced in 2002 and held in inventory until it is sold in 2004 would be included in which years GDP?
A) Half the value in 2002 and half the value in 2004.
B) In 2004 GDP.
C) In 2002 GDP.
D) First included in 2002s GDP, but subtracted two years later and to be added to 2004s GDP.
E) Will not be measured in GDP since the sale was delayed.
Which of the following events is likely to decrease an economys export sales?
A) A decrease in domestic real GDP.
B) A depreciation of this economys currency.
C) A decrease in the domestic price level.
D) A decrease in the income of the foreign trading partners.
E) All of the above.
7.
If the MPC is 0.8 and the government increases spending by $100 million, then we would expect the result to be
A) An increase in real GDP of $500 million.
B) A reduction in equilibrium real GDP of $80 million.
C) An increase in equilibrium real GDP of $100 million.
D) No change in equilibrium real GDP.
E) An increase in equilibrium real GDP of $180 million.
8.
9.
Suppose that the Japanese yen appreciates against the U.S. dollar. We would expect:
A) Foreign travel by Japanese citizens to the U.S. to decrease.
B) The level of exports from Japan to the U.S. to increase.
C) The level of exports from the U.S. to Japan to increase.
D) Both A and B.
E) None of the above.
10. If taxes were constant, then the size of the expenditure multiplier______ it would be if taxes were proportional to income.
A) Could be either larger than or smaller than
B) Is larger than
C) Is equal to what
D) Is smaller than
E) None of the above.
11. Because pollution reduces economic welfare, on this count real GDP
A) Increases to take into account the expenditures that will be made in the future to clean up the pollution.
B) Decreases as pollution increases.
C) Overstates economic welfare.
D) Understates economic welfare.
E) Both B and D.
12. If a countrys current account is negative, this country is a ____ and its balance of payments is ____.
A) Lender, zero.
B) Borrower, zero.
C) Lender, positive.
D) Borrower, positive.
E) Lender, negative.
13. The Canadian dollar (C$) can buy around US$0.92. If the Bank of Canada wants the C$ to strengthen further,
A) It should reduce taxes.
B) It should purchase bonds in the open market.
C) It should raise interest rates.
D) It should do B and C only.
E) It should do all of the above.
14. Flexible exchange rates ____ to stabilize the economy, and fixed exchange rates _____ to stabilize the economy
A) Offset the impact of monetary policy; reinforce the impact of monetary policy.
B) Prevent the use of monetary policy; limit the ability of monetary policy.
C) Strengthen the impact of monetary policy; strengthen the impact of monetary policy.
D) Strengthen the ability of monetary policy; limit the ability of monetary policy.
E) Limit the ability of monetary policy; limit the ability of monetary policy.
15. The aggregate demand curve is:
A) Vertical if full employment exists.
B) Horizontal when there is considerable unemployment in the economy.
C)Downward sloping because of the interest-rate, wealth or real balances, and foreign trade effects.
D)Downward sloping because production costs decrease as real output increases.
E)None of the above.
16.
If the current account has a balance of -$100 and the capital account has a balance of $80, then there will be _ in official
reserves of _.
A) A decrease; $20
B) An increase; $20
C) An increase; $180
D) A decrease; $180
E) None of the above.
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17. A newspaper headline reads: "Bank of Canada Raises the Target Overnight Rate for Third Time This Year." This headline
indicates that the Bank of Canada is most likely trying to:
A) Stimulate the economy.
B) Increase the money supply.
C) Reduce the cost of credit.
D) Reduce inflationary pressures in the economy.
E) All of the above.
18. If a $100 billion increase in investment spending creates $100 billion of new income in the first round of the multiplier process
and $60 billion in the second round, the multiplier in the economy is
A) 4.
B) 5.
C) 3.33.
D) 2.5.
E) None of the above.
19. If the reserve ratio of all commercial banks is 0.3 and the currency deposit ratio of the public is 0.2, then an open market
purchase of bonds by the central bank of $100 million will result in
A) $333.33 million increase in money supply.
B) $240 million decrease in money supply.
C) $240 million increase in money supply.
D) $333.33 million decrease in money supply.
E) None of the above.
20. Pluto, 200,000 people are in the labour force and the unemployment rate is 5%. As Pluto moves out of a recession and the
prospect of finding jobs increases, 10,000 previously discouraged workers become "encouraged" to search for jobs. The
unemployment rate becomes
A) 5%.
B) 9%.
C) 10%.
D) 12.5%.
E) None of the above.
21. Suppose Cindy deposits $700 in currency at a commercial bank. Later that day Dave borrows $1,000 from the same bank. This
money supply would have
A) Increased by $1,000.
B) Increased by $700.
C) Decreased by $1000.
D) Decreased by $700.
E) Stayed the same.
22. Suppose our current nominal wage is $20 per hour, and the current CPI is 120. Our labour unions are currently negotiating with
the firms for a new nominal wage for next year. Our unions want us to be able to afford the same goods and services that we
typically buy. If we agree to a new nominal wage of $25 per hour, this implies we believe the CPI for next year to be
A) At most 135.
B) At most 150.
C) At most 175.
D) At most 190.
E) Cannot be determined.
23. Empirical evidence for Canada suggests that if actual GDP grows by 2 percent a year and potential GDP grows by 3 percent a
year:
A) The unemployment rate will be unchanged.
B) The unemployment rate will fall by 1 percentage point.
C) The unemployment rate will rise by of one percentage point.
D) The economy will experience an inflationary gap.
E) Both B and D.
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24. Consider this quote from Person A: I am working full-time right now, and I have the money to buy a $3,000 bike. However, I
feel uncomfortable because we do not know if we would have a general election soon, and what kind of economic policies the
new party would introduce. I am going to wait and see how things turn out before I buy my bike. This statement captures
A) Person As Marginal Propensity to Save or saving habit.
B) Person As Marginal Propensity to Consume or spending habit.
C) Person As level of consumer confidence.
D) Both A and B.
E) None of the above.
25. Under a fixed exchange rate system in which the C$ is fixed against the US$, if the Bank of Canada (Bank) attempts to raise
interest rates relative to the U.S. interest rates, then it would lead to
A) A downward pressure on the value of the Canadian dollar and a depletion of the Banks US$ reserves.
B) A downward pressure on the value of the Canadian dollar and an accumulation of the Banks US$ reserves.
C) An upward pressure on the value of the Canadian dollar and a depletion of the Banks US$ reserves.
D) An upward pressure on the value of the Canadian dollar and an accumulation of the Banks US$ reserves.
E) None of the above.
Part II: Answer FIVE of the following seven questions in the allotted space. If more than five questions are
answered, only the first five will be marked. State whether each statement is true or false and explain. Use graphs
to support your answers when applicable. No marks will be awarded to simply stating true or false without
explanation (Total=25 marks).
1.
The causes of the U.S. high trade deficits can be explained by examining the concepts of total leakages and total
injections.
Ans: True S+T+Z = I+G+X, so NX=(S-I)+(T-G) if the US T, G, low S, high I, then it has to borrow
from other countries NX<0.
2.
Adopting a fixed-exchange-rate policy for our currency means that the central bank can pursue a monetary policy
that is independent of foreign influences.
Ans: False Adopting a fixed-exchange-rate policy for our currency means that we are obliged to buy and
sell foreign exchange, when needed, in order to maintain its declared parity. This implies that our monetary
policy is not free to set stabilization objectives that could disturb the currencys parity. For example, if i F
rises, this leads to increase demand for F assets, demand for F$, pressure for our C$ to depreciate our
central bank has to supply the F$ demanded and buy C$.
3.
The target overnight interest late is always higher than the bank rate, and the lowest sensible or effective target
overnight interest rate is equal to zero (0).
Ans: False Setting the target overnight interest rate actually creates an operating band of a width of 50
basis points (0.5%) around the target overnight interest rate. The bank rate is the upper limit of the
operating band, which implies that the bank rate is 25 basis points (0.25%) above the target overnight
interest rate (deposit rate, overnight interest rate, bank rate), with difference of 0.25% for each.
Since the deposit rate cannot be lower than zero, the lowest sensible overnight rate is 0.25%.
4.
The simultaneous occurrence of an increase in the price of oil and an increase in government spending would
increase output while leaving prices unchanged. (Hint: Draw a graph to facilitate your answer)
Ans: False An increase in the price of oil will increase the cost of production which implies a leftward
shift of the AS curve (contractionary AS shock). This entails an increase in prices and a reduction in output.
An increase in government spending implies a rightward shift of the AD curve (expansionary AD shock).
This entails an increase in prices and an increase in output. The combination of the two shifts will result in a
certain increase in prices but an ambiguous result on output depending on the relative strength of each of
the two shifts.
5.
A decrease in private saving in a country will result in more spending, which will in turn increase current and
future output and employment in this country.
Ans: False True in the short run but not in the long run, as low saving means less funds available to
finance investment (paradox of thrift).
6.
The crowding out of private investment can never be prevented even with the coordination of fiscal and
monetary policies.
Ans: False Crowding out refers to the phenomenon that when G , Y, Md, i I .
If Ms to keep i constant, then it is possible to prevent crowding out I.
7.
Part III: Answer FOUR of the following five questions. If more than four questions are answered, only the first
four will be marked (Total=60 marks).
Question # 1 (15 marks)
The data in the below table shows the total output (a mixture of consumer, capital, and government services) and prices
of each product for the distant country of the United States (All figures are in billions and the base year is 2003).
Note: Please round your answer to 2 decimal places.
2003
2004
2005
nGDP
NGDP
P in 2003
RGD
P
nGDP
P in 2003
rGDP
Hot dogs
40
200
50
300
250
50
400
250
CDs
16
128
16
20
320
16
256
16
24
384
16
256
Tractors
160
1280
180
1,440
160
1,280
200
1,600
160
1,280
Parking
150
900
160
960
150
900
180
1,080
150
900
Total
2508
(i) Complete the table and use the space below for derivations (4 marks).
(ii) Find the values of nominal GDP, real GDP, GDP deflator, and inflation rate in 2004 and 2005 (4 marks).
Ans: Year 2004 Total nominal GDP should be 3,020; Total real GDP should be 2,686; GDP
Deflator should be 112.43. Inflation rate should be 12.43.
Year 2005 Total nominal GDP should be 3,464; Total real GDP should be 2,686; GDP Deflator
should be 128.97. Inflation rate should be 14.71.
(iii)Suppose that the population in the United States as follows:
2003 80 million
2004 90 million
Find the values for real GDP per capita in 2003, 2004 and 2005 (3 marks).
Ans: For year 2003, Real GDP per capita should be 31,350; For year 2004, Real GDP per capita
should be 29,844.44; For year 2005, Real GDP per capita should be 26,860.
(iv) Find the real GDP per capita growth rates for 2004 and 2005 (2 marks).
Ans: For year 2004, Growth rate should be -4.8.
For year 2005, Growth rate should be -10.
(v) What is the inflation rate in 2004 and 2005 using the CPI, where CPI in 2003 is 100? (2 marks).
Ans: Cost of living in 2003 = 2508
Cost of living in 2004 = 6x40 + 20x8 + 180x8 + 160x6 = 2800
Cost of living in 2005 = 8x40 + 24x8 + 200x8 + 180x6 = 3192
Price index(2003) = 100
Price index(2004) = (cost of living in 2004/cost of living in 2003)*100 = (2800/2508)*100 = 111.64
Price index(2005) = (3192/2508)*100 = 127.27
Inflation in 2004 = ((111.64 - 1000)/100)*100 = 11.64%
Inflation in 2005 = ((127.27 - 111.64)/111.64)*100 = 14%
Question # 2 (15 marks)
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Suppose that in 1996, the price levels in United States and Canada were 100. By 2000, the price level in United States
has increased to 230, while the price level in the Canada rose to 220. Suppose the exchange rate between two countries in
1996 was $1USD = $1.7CAD
Note: Please round your answers to 2 decimal places.
(i) Find the inflation rate of United States. (2 marks)
Ans: 130%
(ii) Find the inflation rate of Canada. (2 marks)
Ans: 120%
(iii) What was the 1996 real exchange rate? (2 marks)
Ans: The real exchange rate was E = e PUnited States PCanada = 1.7 100 100 = 1.7
(iv) What must the new nominal exchange rate have been in 2000 if the real exchange rate remained constant? (2 marks)
Ans: We know that real exchange rate (E) = e PUnited States PCanada
Now, we want E = 1.7, so 1.7 = e (230 220), so e = 1.63
(v) Suppose, United States has a fixed exchange rate system against the Canadian dollar. The initial nominal exchange
rate is fixed. As a result, did Canada's real exchange rate appreciate or depreciate? Explain (3 marks).
Ans: The actual E = 1.7 230 220 = 1.78. This means Canada has a real exchange rate depreciation.
(vi) Would you expect Canada's net exports to rise or fall as a result? Explain (2 marks).
Ans: Canada's net exports would rise. Intuitively, since one USD could still buy only 1.7CAD and the
Canada's price levels have increased, Canada's exports are in fact now less expensive. If this relatively low
inflation rate had been offset by allowing one USD to buy 1.63CAD, Canada's exports would not have gained
any competitiveness. Since a fixed exchange rate system does not allow the nominal rate to change, its net
exports have been increased.
(vii) Is the Canadian dollar overvalued or undervalued? Explain (2 marks).
Ans: Undervalued, because it should have taken 1.63 CAD to buy one USD, not just 1.7 CAD. The value of
the CAD is too high.
Liabilities
Reserves
$36.00
Loans
$84.00
(ii)
$120.00
Person B borrows this money as loans and pays to Person C. Suppose Person C deposits this amount with Bank B.
Bank B, similar to Bank A, also chooses a reserve ratio of 0.3 and issues the remaining cash as loans to Person D.
Record the effect of this transaction on the balance sheet below: (2 marks)
Assets
Liabilities
Reserves
$25.20
Loans
$58.80
(iii)
Deposits
Deposits
$84.00
Person D borrows this money as loans from Bank B and pays to Person E. Suppose Person E deposits this amount
with Bank C. Bank C also chooses a reserve ratio of 0.3 and issues the remaining cash as loans to Person F.
Record the effect of this transaction on the balance sheet below: (2 marks)
Assets
Liabilities
Reserves
$17.64
Loans
$41.16
Deposits
$58.80
(iv)
Using the information from the previous questions, and assuming that all loans carried forward will be deposited
in a bank with the same reserve ratio, show how the deposits are related to (1 + 0.7 + (0.7) 2 + (0.7)3 + ...). (2
marks)
Ans: Deposits: The first deposit should be $120.00; The second deposit should be $84.00; The third deposit
should be $58.80; The fourth deposit should be $41.16; The first term of the sum is the proportion of the
initial cash deposited in the bank the first time. It is always 1.
(v)
(vi)
(vii) Suppose the reserve ratio is now 0.35. If Person A had deposited his $120 NOW, what would be the amount of
money created NOW? (3 marks)
Ans: The amount of money created can be calculated as [multiplier primary deposit] - primary deposit. In
this case the calculation is as follows: New money supply = $120.0 [ 1 / ( 1 - 0.65 )] or $120.0 [ (1 / 0.35] =
$342.86. The amount of money created = [new money supply] - [original deposit]
The amount of money created is therefore $222.86.
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C = 110 + 0.8(Y-T)
I = 1,100 - 5,800i
G = 550
T = 550
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50
The Conference Board of Canada has recently announced that consumer confidence in Canada dropped. Let the drop in
consumer confidence to be equal to 10 points, from 110 to 100, so now C = 100 + 0.8(Y-T).
(ii)
(iii)
(iv)
Demonstrate how the drop in consumer confidence would affect the economy through the multiplier. Use three
rounds of effects to demonstrate the multiplier effects. Let the first round be related to car purchases, the second
round related to clothing, and the third round related to food (3 marks).
Ans: C drops by 1, so we buy one fewer cars. Car works have $1 less in income, so they spend $0.80 less on
clothing (they still have to wear something, the $0.20 worth of clothing!). Clothing workers have $0.80 less
income, so they spend $0.64. less on food (they still have to eat, the $0.16 worth of food), and so on...
(v)
Suppose the Bank of Canada (BOC) is trying to reverse this adverse effect on the economy. For simplicity, it is not
concerned about inflation for now. The BOC can drop the bank rate in order to stimulate investment spending (I).
Suppose you work for the BOC and your boss Mark Carney has just dropped by your office to ask you what he
should do. You need to find the new interest rate that is required to stimulate I. The increase in I has to be
sufficient to push the overall Y level back to the original Y level that you have found in (i) (4 marks).
Ans: We want Y to rise from 5,925 back to 5,975. We know that C = 100 + 0.8(Y-T), G = 550, T = 550, NX =
20, so set Y = C + I + G + NX = 5,975 and solve for I, I = 965. This is sensible since we want I to rise and
offset the drop in C confidence. Now solve for i that would give I = 965, and i = 0.0233, or 2.33%. This is also
sensible because the BOC would need to drop i from 2.5% to 2.33% in order to increase I, increase jobs,
increase Y, etc... just as you have described before in words, but now we know the actual amount of interest
cut that is required.
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(i)
Article 1: Based on your understanding of the money multiplier, why are some commercial lenders under credit
crunch? What is the effect on the money supply? Explain (4 marks).
Ans: Banks hold a fraction of their deposits as reserves and issue the rest of the deposits as loans to
customers. The banks have lent a lot more money than we as customers have deposited. If the loans are
solid, this is not a problem. But if the borrowers as a group could not pay back their debts, the banks are in
trouble. The money supply shrinks as bad loans mount.
(ii)
Article 2: Use the Y=AE and AD/AS/LAS diagrams to illustrate how Canadas economy will be affected in the
short run. Explain in words which curve(s) would shift and why. How would the unemployment rate and inflation
rate be affected? Explain (4 marks).
Ans: The drop in consumer confidence shifts down AE and AD since spending is weaker Unemployment
rate will rise via Okuns law inflation/price level will drop via recession.
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(iii) Article 3: Define SRA and SPRA. If the Bank of Canada needs to intervene in the money market to stop the 0.25%
interest rate from rising, should it conduct SRA or SPRA? Explain (4 marks).
Ans: SRA = sale and repurchase agreements, drains cash from banks SPRA= special purchase and resale
agreement, injects cash into banks Need to conduct SPRA if it wants to keep overnight interest rates low
at 0.25%.
(iv)
Article 3: The cut in the target overnight interest rate is very likely to lower borrowing costs for consumers and
firms who need loans from commercial banks to finance their purchases. However, there are also consumers and
firms who have sufficient money to pay for their purchases without any bank loans. Would the cut in interest rates
have an effect on the spending of these consumers and firms? Explain (4 marks).
Ans: Yes, since the money previously put into GICs or any interest bearing assets would now yield lower
returns. As the returns drop, the opportunity cost of cashing them and using the money to start a project
also drops hence more likely to start a business project.
(v)
Article 4 states that the federal government tries to stimulate the Canadian economy by cutting income taxes as
well as increasing government spending. Referring to the concept of the goods market autonomous multiplier,
explain whether a $1 cut in income taxes would have the same effect on the economy as a $1 increase in
government spending (4 marks).
Ans: No If G rises by 1, first round (immediate injection) says Y rises by 1. If T drops by 1, first round
says Y rises only by consumption. Since MPC<1, then Y rises less than 1 G increase has a more direct and
powerful effect on Y than a T cut.
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(vi)
Article 5: State the difference between budget balance (BB) or structural budget balance (SBB). Which
measurement would reflect a larger deficit? If we believe the recession is only temporary, should we examine our
fiscal budget health by looking at BB or SBB? Explain (4 marks).
Ans: BB=tY-G, SBB=tYp-G, and BB likely to show larger deficit than SBB since Y would have dropped
under BB. We should focus on SBB which assumes Y=Yp. As Y recovers back to Yp over time, a portion of
BB deficit shrinks automatically.
(vii) Articles 4+5: Explain in words (no graph necessary) how these monetary and fiscal policies will affect the
AD/AS/LAS diagram, i.e., which curve(s) would shift. How are unemployment and inflation rates affected?
Explain (4 marks).
Ans: The in money supply or in interest rates will shift up I and AD the G and T will shift up G
and C and AD This brings us back to Y=Yp unemployment and inflation rates go back to the initial
values prior to the credit crisis.
(viii) Articles 1+2: Suppose that neither the Bank of Canada nor the government responds to the economic slowdown.
Use the AD/AS/LAS diagram to graphically explain how the Canadian economy will adjust back to the long run
equilibrium Yp. Also describe in words how your answer relates to the Phillips Curve (4 marks).
Ans: Wages will , AS shifts right (down), back to Yp; PC says wages if Y<Yp, which shifts the AS.
Unemployment rate goes back to the natural rate Inflation drops to a new, lower value (since both AD
and AS have shifted downward).
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(ix) Article 6: Explain why some financial traders believe that a rise in our interest rate would most likely lead to an
appreciation of the Canadian dollar. Use the demand-and-supply diagram for the U.S. dollar to support your
answer. Hint: Be careful with how you define the nominal exchange rate between the C$ and U.S.$ (4 marks).
Ans: As Canadian interest bearing assets pay a higher interest rate, our assets become more profitable
foreigners (Americans) increase demand for Canadian assets to buy our assets, they increase demand for
C$ and sell US$ supply of US$, US$ depreciates while C$ appreciates the exchange rate e drops.
(x)
Article 7: Suppose biologist Greg Goss project is a big success. How would Canadian GDP be affected? In the
AD/AS/LAS model, which curve will be affected? If the Bank of Canada always wants to target the same, constant
inflation rate of 2%, what should it do? Explain in words, no graph necessary (4 marks).
Ans: LAS shifts right since an improvement in technology/productivity can increase Yp permanently. The
increase in Y=Yp will drive down the equilibrium inflation rate the BOC has to cut interest
rate/increase money supply, AD and push the equilibrium back to 2%.
The End
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